How would you like to buy a dollar of investments for 85,
90, or 95 cents?
You can.
You can do it every day. It's about the
closest thing to free money going. All you have to do is get familiar with the
original Exchange Traded Funds, the small world of closed-end funds. While
exchange traded funds get all the attention, closed end funds routinely offer
interesting opportunities.
Just don't
expect a printed invitation.
While the burgeoning
universe of ETFs has soared to over 194 funds with over $322 billion in assets
in only 13 years, a
universe of 710 closed-end funds has gathered only $233 billion in assets in a history that stretches back more the 70 years.
Like ETFs, closed-end funds are portfolios that trade like a stock. Like ETFs,
closed-end funds can specialize in municipal bonds, junk bonds, foreign stocks,
and particular sectors of the stock market.
Unlike
ETFs, closed-end funds can trade at wide discounts (and premiums) to the net
asset value of the underlying portfolio. That's what creates the opportunities
for you and me. There are different theories for why these funds often sell at
a discount. Some say they lack brokerage firm attention after being launched.
Others say the discount reflects the tax liability in unrealized capital gains
some of the funds have. Still others say the discount may result from high
expenses, poor performance, or both.
What's
important is that deep discounts bring moves to convert the funds to open end
and you and I have regular opportunities to buy low and sell higher.
Even if we
don't sell, buying assets at a discount can work to provide us with higher
yields and/or the equivalent of free money management.
How's that?
Suppose a
portfolio of stocks has a dividend yield of 2 percent and you can buy the
portfolio for 85 cents on the dollar. That means you get a yield of 2.35
percent. In
today's investment income starved world every little bit helps. This is
particularly good when you participate in a dividend reinvestment plan. The
larger dividend buys more shares at a discount.
Then again,
you could view the discount as a subsidy for the cost of management. While ETFs
are celebrated for their low cost relative to managed mutual funds, sporting
expenses as low as 9 basis points or .09 percent a year, some closed end funds
could be considered to have free or
even subsidized management.
How? If you
buy $1.00 of assets for 85 cents, you're getting the earning power of the other
15 cents for nothing. If a fund earns 10 percent a year and costs 1.5 percent
to manage, that 15 cents you didn't pay for is earning 1.5 percent--- enough to
pay the entire cost of managing the fund.
The CEF
game, if you want to play it, has simple rules. First, never buy a closed end
fund when it is issued: You'll pay a hefty premium and most funds eventually
sell at a discount. Second, use the websites that report on CEF pricing--- the Wall Street Journal and Morningstar both
present historical graphs. Buy when the discounts are average or higher.
On the web:
Wall Street Journal (go to Markets, Market Data
Center, and Closed-end
funds under "Mutual Funds and ETFs"
www.wsj.com
Final URL for WSJ listings
http://online.wsj.com/documents/CEFmain.html
Morningstar (enter "Closed-end funds" in search to find news)
www.morningstar.com
Closed-end fund association
http://www.closed-endfunds.com/
Private Clubs/Ready Money: "The ETF Revolution",
January/February 2006
http://www.privateclubs.com/archives/2006-jan-feb/life_ready-money.htm
